What is fiat money and how does it differ from cryptocurrency?

Bitsgap

·

2018-12-12

If you’ve been in cryptocurrency for more than about two seconds, then you’ve likely heard someone talking about its many merits over fiat money. What is fiat currency though?

In this article, we’ll go over the main differences between these traditional currencies and new digital ones. What are the advantages and disadvantages of using fiat comparing to the cryptocurrency? Let’s find out!

What is fiat money?

Fiat money is a currency that has been distributed by a country’s government. They have declared it to be legal tender for all debts, but it’s not backed by any type of commodity, like gold.

Its value comes from the relationship of supply and demand and the faith that people have in that currency to maintain value thanks to its relationship to the country that controls it. While fiat currency can be useful, the idea of a currency with no value behind it does not sit well with many people who are wary of them.

How was fiat currency created?

Fiat currencies were created in order to make trade easier and to allow for the storage of wealth. Originally, currencies like the US dollar were printed and redeemable for its face value in gold.

The relationship here was eventually severed to control inflation and deflation, which were issues with the previous gold backed system, and now the US dollar is backed purely be reputation and the monetary system which the US government controls.

While this does help to keep a system in place that is balanced and reliable, it does not mean that the value does not change. In fact, forex markets allow you to make money based on the changing of value between different fiat currencies of the world.

Fiat money example

The US dollar is an example of a fiat currency. It is not backed by any kind of physical commodity, and its value depends upon the US government. This value comes of course from the way that the government is managing its economy, and that value is subject to change. This is where exchange rates come in when you go from one fiat currency to another.

How fiat currency is backed?

While at one-time fiat currency in the United States was backed by the gold standard, that is no longer the case. Fiat money is now only backed by promises of the government who has issued it and the underlying supply and demand which balances its value.

There are a number of opponents to this approach who do not like the fact that the US abandoned the gold standard because there is no safeguard of value. Only promises which could end up being empty if something catastrophic were to ever happen.

Fiat money advantages

Fiat money has some advantages though. Without being tied to gold, it makes it easier to control the value and stop disasters. For example, the United States government can control the value of the US dollar to keep catastrophic events, like the 2008 recession, from crashing the value of the currency. Since the “redeemable” value of the US dollar is constant, it also makes it easier for trade purposes and storage than a currency which constantly goes up and down in value.

Fiat money disadvantages

There are some disadvantages to fiat money as well. Despite the system checks in place, fiat money can still be greatly impacted by inflation. You also, of course, have the problem of a corrupt government causing their issued currency to go to zero value.

This is not some dystopian future of fantasy novels, there really are countries with this problem, and it’s a very real threat. Hyperinflation is a serious concern, and it can occur if a government gets too overzealous in their acts of printing new money.

Fiat money versus cryptocurrency

Fiat currencies and cryptocurrencies function differently. Cryptocurrencies are more democratic in their approach, and while the system is not foolproof, it does make it much harder for one centralized entity to ruin the system since all participants must agree on changes.

Cryptocurrencies also tend to resist inflation since they have limited supplies. Unfortunately, crypto assets also have trouble holding stable values, and that can make it difficult to depend on them for day to day expenses and business usage where even small price variances can cause profit margins to vanish, leaving merchants in the red.

Can cryptocurrency replace fiat money?

It seems like a real possibility, and in fact, there are already governments working on issuing their own cryptocurrencies. For a decentralized cryptocurrency to replace fiat currencies, it would need to be able to prove itself as reliable first, and it’s likely that it would also need to be a pegged asset that could perform similar tasks to the US dollar while still providing the benefits of crypto.

Fiat currency and inflation

The value of fiat money carefully tethers on the balance of supply and demand, but there is no real cap to the amount of fiat money which can be printed. That means that it’s up to the government to control this supply and demand.

However, a corrupt government could just keep printing more money, and if their management is poor, then hyperinflation can soon take over and ruin the currency. Since there are no commodity backing or supply limitations, these things can quickly spiral out of control, and it’s one of the main issues that cryptocurrency was created to address.

Future of fiat currency

It seems likely that in the future governments will want to issue their own cryptocurrencies. New fiat currencies which are digital. A decentralized currency seems unlikely, but a government-issued crypto coin would provide superior tracking capabilities thanks to the blockchain.

Paper money will most likely be long gone, but fiat principals will remain, as they will still want to have complete control of it. Of course, traditional cryptocurrencies will still function right next to them as they always have. How will this impact how the world does business? We’ll just have to wait and see.